Question

a. find a price of Bond A, a 1-year zero-coupon bond, which has a return of 6.6% and a face value of $1000. Show calculations and formula.

b. would you prefer Bond A to Bond B, a 1-year zero coupon bond which sells for $ 910 and has a face value of $1000, show and explain.

c. would you prefer Bond A , Bond B or Bond C is a 1-year zero coupon bond with face value of $500 and sells for $470, show and explain

Answer 1

(a) If Bond price be P, then

P x 1.066 = $1,000

P = $1,000 / 1.066 = 938.09

(b) If return on bond B be R% per year, then

$910 x (1 + R) = $1,000

1 + R = $1,000/$910 = 1.0989

R = 0.0989

R = 9.89%

Since return on bond B is higher than return on bond A (9.89% > 6.6%), I will prefer bond B.

(c) If return on bond C be R% per year, then

$470 x (1 + R) = $500

1 + R = $500/$470 = 1.0638

R = 0.0638

R = 6.38%

Since return on bond B is highest than return on bond A (9.89% > 6.6% > 6.38%), I will prefer bond B.